Commercial Ground Lease Fundamentals

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June 28, 2018


Commercial Ground Leases

When leasing commercial grounds for the said purpose there are some rules that must be followed in doing so. There are also a variety of pros and cons to leasing commercial grounds for construction purposes versus purchasing the land directly or obtaining it through other means.

Ground or land leases are fairly common agreements, it's important to understand what is involved with a ground or land lease versus another form of obtaining land to do construction on. Moreover, land leases will expire and have to be renewed, which can cause a problem if you build property on that land and later the party who leased it is no longer interested in leasing it. However, land leases usually last a good while, anywhere from 25 years and some up to 99 years in length.

The following are the two types of ground or land leases that are usually offered:

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Two Types Of Ground Leases:

Subordinated Ground Lease:

A subordinated ground lease is a lease where the owner of the property agrees to become the second owner to the person who they have leased the land to. The owner is offering the land as collateral for the loan on the improvements which will make them a junior or secondary lender to a project that is going to take place on that specific piece of land. Subordinated ground leases will often be done when building projects are being undertaken that can help raise the value of their other surrounding properties. This also provides the owner of the land with additional benefits outside of the subject transaction.

Unsubordinated Ground Lease:

Unsubordinated ground leases allow owners to maintain the primary ownership of the land and they are still listed first on the financial statements or when the property is claimed as an asset. The lender has the right to take back the land any time if the tenant defaults on the payments or on the conditions of the leasing of the land. This position is considered much safer for the landlord and for the tenant it usually comes with a much lower lease rate.

Pros & Cons Of Ground/Land Leases:

Now that we understand the basics of both types of leases, the following are some of the pros and cons to consider when leasing land versus buying it permanently:

Pros To Leasing Land Rather Than Buying It:

  • land that is up for lease may provide you with premium land that was not for sale for you to buy permanently
  • these leases also contain reversion clauses which often hand the land back to the landlord at the end of the lease and that includes any repairs that need to be made -- once the lease is over these repairs are often the responsibility of the landlord not the person who leased the land (saves you money)
  • some payments for leased land can be tax-deductible (depending on your specific situation)
  • many can contain provisions that offer additional flexibility for the person leasing the land
  • leases may be able to be extended or terminated at the wishes of the person leasing (based on the wishes of the landlord to extend the lease)
  • may be more affordable than purchasing land outright and save the person leasing the land from having to take out more loans as debt that purchasing the land outright
  • is great for shorter-term projects that may not last indefinitely (i.e. a temporary location for a business or company)

Cons To Leasing Land Rather Than Buying It:

  • if problems occur with the land while it's leased to you are often responsible for all costs associated with repairs
  • leases often are only for an extended period of time and if they expire the landlord may not want to lease the land again leaving you in a bind
  • you may lose out on the equity the property gains during the lease when you return the land to the landlord or they may only give you a percentage of the equity you otherwise would own
  • escalation causes can cause problems for the tenant leasing the land which may result in eviction if the issues cannot be resolved - this can pose an uncertainty for you as the person leasing the land

Did You Know Many Leases Are Negotiable?

Many leases have terms that are able to be negotiated including provisions that both parties may agree on which will offer lots of flexibility on everything from terms and conditions to the amount paid to lease the land in the first place. Talk to the landlord and explain what you want in a lease (i.e. length of lease, price you can pay, how much equity you want returned to you after the lease is up, etc). If your desires match what they are willing to do, you may be able to make a great deal that benefits both parties!

If you strike a good deal with a quality landlord, this can make the leasing worthwhile, especially if you lease for a long period of time such as 99 years. Long as there are no provisions for the landlord being able to take the money away, you are likely to never have to worry about renewing the lease again!

However, most leases that have provided for certain amends to be made have the conditions of the lease reviewed every 5 or 10 years. This is a common practice as many leases last anywhere from 50-99 years.

Conclusion:

Ground or land leases for commercial purposes can benefit both the landlord and the tenant in a variety of situations. You will have to be flexible with the landlord and they often have to be flexible with you. Coming to terms on agreements for the land lease can make a lease a great deal for everyone involved, especially since it can be lighter on your pocketbook than buying the land outright. This can help keep your company or business out of debt and can help the landlord increase the value of their land to help increase the value if they own surrounding properties through partnering with you in the meantime.

For more information on commercial ground or land leases and to see which ones may be right for you, please feel free to contact us.

Sources:

http://cltnetwork.org/wp-content/uploads/2014/07/16-Nonresidential-CLT-Ground-Leases.pdf
https://www.nolo.com/legal-encyclopedia/commercial-lease-basics-29934.html


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